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Chapter 22

Chapter 22. Decentralization and Performance Evaluation. Conceptual Learning Objectives. C1: Distinguish between direct and indirect expenses and identify bases for allocating indirect expenses to departments. C2: Explain controllable costs and responsibility accounting.

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Chapter 22

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  1. Chapter 22 Decentralization and Performance Evaluation

  2. Conceptual Learning Objectives C1: Distinguish between direct and indirect expenses and identify bases for allocating indirect expenses to departments. C2: Explain controllable costs and responsibility accounting. C3:Appendix 22A: Explain transfer pricing and methods to set transfer prices. C4:Appendix 22B: Describe allocation of joint costs across products. 22-2

  3. Analytical Learning Objectives A1: Analyze investment centers using return on total assets, residual income and balanced scorecard. A2: Analyze investment centers using profit margin and investment turnover. 22-3

  4. Procedural Learning Objectives P1: Prepare departmental income statements and contribution reports. 22-4

  5. Provide informationfor managers to usein performanceevaluation. To control costs and expenses and assist with evaluating managers performances. Departmental Accounting C1 Primarygoals 22-5

  6. Information forDepartmental Evaluation C1 The accounting system provides information about resources used and outputs achieved. Managers use this information to: • Control operations. • Appraise performance. • Allocate resources. • Plan strategy 22-6

  7. Costcenter Profitcenter Evaluated on ability tocontrol costs. Evaluated on abilityto generate revenuesin excess of expenses. Information forDepartmental Evaluation C1 The type of accounting information provided depends on whether the department is a . . . 22-7

  8. Information forDepartmental Evaluation C1 Investment Center Evaluated on their use of center assets to generate income. 22-8

  9. Departmental Expense Allocation C1 Direct expensesare incurred for the sole benefit of a specific department. Indirect expensesbenefit more than one department and are allocated among departments benefited. 22-9

  10. Illustration of IndirectExpense Allocation C1 Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies. 22-10

  11. Illustration of IndirectExpense Allocation C1 Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies. 22-11

  12. Illustration of IndirectExpense Allocation C1 Classic Jewelry pays its janitorial service $300 per month to clean its store. Management allocates this cost to its three departments according to the floor space each occupies. 22-12

  13. Bases for AllocatingService Department Costs C1 Service department costs are shared, indirect expenses that support the activities of two or more production departments. 22-13

  14. Service Department CostsQuestion C1 ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a. $100,000 b. $120,000 c. $150,000 d. $180,000 22-14

  15. Service Department CostsQuestion C1 ABCO allocates its $300,000 personnel cost to operating departments based on the number of employees in each department. The assembly department has 100 employees and the packing department has 150 employees. What amount of cost is allocated to assembly? a. $100,000 b. $120,000 c. $150,000 d. $180,000 Assembly percentage= 100 ÷ (100 + 150) = 40% 40% of $300,000 = $120,000 22-15

  16. Let’s prepare departmental income statements using the following steps: • Direct expense accumulation. • Indirect expense allocation. • Service department expense allocation. Preparing DepartmentalIncome Statements P1 22-16

  17. Departmental ExpenseAllocation Spreadsheet P1 22-17

  18. Departmental ExpenseAllocation Spreadsheet P1 Step 1:Direct expensesaretracedto service departments and sales departments without allocation. 22-18

  19. Departmental ExpenseAllocation Spreadsheet P1 Of a total of 12,000 square feet, the service departments occupy 1,500 square feet each, the hardware department occupies 4,050 feet, housewares 2,700, and appliances 2250. Step 2:Indirect expensesare allocatedto both the service and the sales departments based on floor space occupied. 22-19

  20. Departmental ExpenseAllocation Spreadsheet P1 Step 3: The Service departmenttotal expenses(original direct expenses + allocated indirect expenses) from the two service departments areallocatedto three remaining operating or sales departments. 22-20

  21. Departmental Income Statements P1 22-21

  22. Departmental Income Statement P2 22-22

  23. P1 Departmental Contribution to OH 22-23

  24. Financial Performance Evaluation Measures A1 • One of the ways to evaluate investment center managers is to use a measure called return on investment (or return on assets.) • The formula for ROI is as follows: Investment center net income Investment center average invested assets ROI = 22-24

  25. Financial Performance Evaluation Measures A1 • Another measure of evaluating financial performance is by computing the investment center’s residual income. Investment Center - Target investment net income center net income Residual Income = 22-25

  26. Balanced Scorecard A1 • The Balanced Scorecard is a system of performance measures, including non-financial measures. • It Is used to assess company and division performance based on four perspectives: • Customer • Internal processes • Innovation and Learning • Financial 22-26

  27. Relating to theresponsibilities ofindividual managers. To evaluatemanagers oncontrollable items. Responsibility Accounting C2 An accounting system thatprovides information . . . 22-27

  28. Controllable Costs C2 I’m in control Costs are controllableif the managerhas the power to determine, or strongly influence, the amounts incurred. A manager’s performance evaluation should be based on controllable costs. 22-28

  29. Distinguishing Controllableand Direct Costs C2 Direct costs are traced to departments, but may not be controllable by the department manager. • Example: Department managers usuallyhave no control over their own salaries. Controllable costs are identified with a particular manager and a definite time period. • All costs are controllable at some level of management if the time period is long enough. 22-29

  30. Responsibility Accounting C2 Successful implementation ofresponsibility accountingmay use organization charts with clear lines of authority and clearly defined levels of responsibility. 22-30

  31. Responsibility AccountingPerformance Reports C2 Amount of detail varies according to level in organization. A store manager receives summarized information from each department. A department manager receives detailed reports. 22-31

  32. Responsibility AccountingPerformance Reports C2 Amount of detail varies according to level in organization. Management by exception: Upper-level management does not receive operating detail unless problems arise. The vice president of operations receives summarized information from each store. 22-32

  33. Responsibility AccountingPerformance Reports C2 To be of maximum benefit, responsibility reports should . . . • Be timely. • Be issued regularly. • Beunderstandable. • Comparebudgetedand actual amounts. 22-33

  34. Investment Center – Analysis A2 • We can further examine investment center performance by splitting down return on investment into profit margin and investment turnover: ROI = Profit Margin X Investment Turnover • This will provide further information on the performance of the unit. 22-34

  35. Profit Margin A2 • The profit margin is the first component in the expanded equation and measures the income earned per dollar of sales. Profit margin = Investment Center Net Income Investment Center Sales 22-35

  36. Investment Turnover A2 • The investment turnover measures how efficiently the company generates sales from its invested assets. • It is used in the second half of the expanded ROI formula. Investment = Investment Center Sales Turnover Investment Center Average Assets 22-36

  37. End of Chapter 22 22-37

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